Compound growth and property

Compound growth and property

Intrinsically speaking, humans aren’t that good at maths. I’m not talking about Stephen Hawking, for example, but your everyday person, even very intelligent people, have a bit of a rough time at being able to estimate things accurately.

It’s basically an economist’s job, and they barely get it right even half of the time. Behaviouralists and predictors of the future who tell you they can predict with accuracy are best avoided.

Don’t worry, we’re going somewhere with this and, yes, it does tie into property at some point.

That being said, there was an article in Wired about the difficulty of predicting growth that grows exponentially, and especially compound growth.

Within it, it was noted that ‘Researchers asked an apparently rather muted question: how much 100 Swedish kroner, if left in a bank account to earn seven per cent interest a year for 30 years, would grow to. Even that simple growth rate baffled respondents. The median answer was 410. The correct answer, 761 kroner, was almost double that. More than 60 per cent of the respondents underestimated the answer.’

So, if nearly two thirds of people can’t even calculate the compound interest of 100 kroner over a fairly short period of time, what might we be missing in property?

Compound interest and how we understand it

There are very few things you can find that are relatively easily available, that are guaranteed to grow at 7% per year over 30 years.

In 1991, the average UK property price was a little over £121,000. 30 years later that average has risen to just over £265,000. Most of us can see that’s risen by over 100% over 30 years, with an average growth of slightly under 3.5% per year.

Not quite 7%, but if that’s reduced over 20 years, we see something closer. Besides that, however, there’s a further point to consider – exponential growth bias.

According to the same article, ‘Psychologists who study how people save for the future have identified the ‘exponential growth bias’ – which makes us underestimate the future size of something growing at a compounded rate. Studies in this area show how people are consistently befuddled by the compound growth of our savings, loans and pension plans.’

For investors

What does this mean for us? Well, quite simply you really do need to consider investing in property the same way as anything.

Nobody can guarantee that your property will grow every single year, but over any 20 period year in recorded history the UK property market has grown by at least 3.3%.

Compound interest is difficult to quantify, but let us put it this way: if somebody asked you to invest £100,000 for a guaranteed growth of 3.3% it doesn’t sound that impressive, does it?

But what if somebody told you they could take your pension pot of £100,000 and guaranteed it would more than double by the time you retired?

The framing of the equation is different, but the result is ultimately the same. If you started with £1 and your savings doubled every year, how long do you think it would take you to become a millionaire? Just 20 years, starting with £1.

This is the advice we like to give our investors too, try and consider things differently.

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